When you’re in debt without a plan to get out, trying to see the light at the end of the tunnel can be as hopeless as Lance Armstrong becoming a legitimate athlete again. It ain’t gonna happen.
You should never want to assume debt. If you watered down what debt really is, it could be explained like this “I’ll give you $110 if you give me $100”. That’s absurd! Yet, millions of people assume debt every year, and approximately 1/3 of the United States has an unpaid debt in collections. If you’re not sure why that’s a big deal, discover the value of good credit.
Creating a plan to get out of debt can help you be realistic about when you can become debt free. It can also provide you with the much-needed motivation to stay on the path to financial freedom. There are two basic ways to approach debt repayment, each having their pros and cons.
The Snowball Method
The snowball method is probably the more widely known method of paying off debt. As popularized by Dave Ramsey, the snowball method means that you pay off your smallest balances first.
Let’s look at how Imaginary Ivan used the snowball effect to his advantage. Imaginary Ivan had three debts – $100 at 8% interest, $500 at 12% and $1000 at 16%. He had $160 to spend on his debts each month, so he paid the minimums of $20 and $40 on the $500 and $1000 balances, respectively. He put the remaining $100 on his smallest balance and paid it off in full.
Next month, Ivan decides to ‘snowball’ that $100 payment from the smallest bill into the $500 debt. Instead of taking 25 months to pay off his $500 debt at $20 per month, Imaginary Ivan’s got that $500 taken care of in a little over 5 months! He then continues the pattern, choosing to roll over all of the money, paying $160 per month on the $1,000 debt. Using this method, Ivan pays of all debts in a little less than 11 months, and pays $99.87 in interest.
The benefit of the snowball method is that it keeps you motivated psychologically. Seeing those smaller balances eliminated is an ego boost that makes you want to continue on. The drawback of the snowball method is that depending on which cards have the highest interest, it may not be the most efficient way of repaying debt in terms of interest savings.
The Avalanche Method
The avalanche method is the alternative to the snowball method. Where snowballing targets the smallest balance first, avalanching focuses on the highest interest rate first. This provides the quickest path to paying off the debt, but isn’t without its downfalls either.
Fictitious Felicia has the same setup as Imaginary Ivan, except she decides to utilize the avalanche method instead of snowballing.
She pays the minimum of $10 on the $100 debt and $20 on the $500 debt, and puts the rest of her available moneys into the $1,000 debt because it carries the highest interest. Once that’s paid off, she moves on to the $500 debt because it carries a 12% interest rate, while the $100 debt only is costing 8% interest. Using the avalanche method, Felicia also takes around 11 months and pays $87.84 in interest.
In this instance, Felicia saved $12.13 over Ivan by choosing to avalanche instead of snowball. However, Felicia had less flexibility in her budget over those 11 months since she was committed to paying $70 in minimum payments, while Ivan freed up two of his debts relatively early.
Manage Your Means’ Recommendations
You should choose the avalanche method if you’re certain that you’re dedicated to staying on track and doing what it takes to get out of debt as quickly as possible, saving the most money.
You should choose the snowball method if you need the motivation to keep going, and paying off bills in full gives you that boost you need! Additionally, the snowball method can free up minimum payments on smaller bills quickly, leaving you with more flexibility should you need it later on in case of emergency.
Do you have another way to repay debts aside from these two methods? Which is your preferred method? Let me know in the comments!